Japan Steel Industry Update - September 17 2012

8/13/2019 Japan Steel Industry Update - September 17 2012

1/32

CONFIDENTIAL

Update on the Japanese Steel Industry

September 2012

Prepared by Fore Research & Management, LP (Fore). Public use or external distribution is prohibited. The information contained in this document is proprietary and

strictly confidential, is intended solely for the person to whom it is delivered and is supplied with the understanding that it will be held in confidence and not copied or

disclosed to third parties without the prior written consent of Fore. By receipt of this document, the recipient agrees that it will, and will cause its directors, partners, officers,

employees, attorneys, agents and representatives to, use the information only to evaluate its potential interest in Fore and the funds it advises, and for no other purpose and

will not divulge any such information to any other party. Reproduction of this information, in whole or in part, is prohibited. The information may also be subject to a separate

confidentiality agreement and the terms contained therein. Notwithstanding anything to the contrary herein, each recipient shall be permitted to disclose the tax treatment

and tax structure of the transactions described herein (including any materials, opinions or analyses relating to such tax treatment or tax structure), but without disclosure ofidentifying information or, except to the extent relating to such tax structure or tax treatment, any nonpublic commercial or financial information

SUBJECT TO FURTHER TERMS & DISCLAIMERS SET FORTH ON PAGE 2 2012 Fore Research & Management, LP


2/32


3/32

3

Agenda

Executive Summary

The Japanese Steel Industry

JFE Holdings Inc.

Kobe Steel Ltd


4/32


5/32

5

Global Steel Relative Value Spread Versus Leverage*

Sources: Company annual reports and Fore Research & Management estimates

Japanese steel companies trade tight compared to US and European

peers.

As of June 30, 2012, JFE and Kobe Steel are net levered (net debt /EBITDA) 5.7x and 5.6x, respectively.

In Europe, ArcelorMittal is net levered at 2.6x, but its CDS is trading at

530 bps. U.S. Steels net leverage is 3.1x and its CDS trades at 685 bps. AK Steels

net leverage is 5.4x and its CDS trades near 945 bps.

Relative Value Spread versus Leverage

*Note: leverage calculations do not include pension or other postemployment

benefit obligations.

0

100

200

300

400

500

600700

800

900

1,000

0.0x 2.0x 4.0x 6.0x 8.0x

CDSspread(bp

s)

Netdebt/EBITDA

AKS

MT

X

KobeSteel

JFE

NipponSteel


6/32

6

Agenda

Executive Summary


JFE Holdings Inc.

Kobe Steel Ltd


7/32

7

Domestic Demand is in Secular Decline

1. The Japan Iron and Steel Federation: Domestic shipment of ordinary steel products by year

2. The Japan Iron and Steel Federation: Domestic steel orders booked in 2011

3. Japan's Shipbuilding Capacity To Sink 1st Time In 10 Yrs, Nikkei article dated July 19, 2012

Sources: Company reports and Fore Research & Management estimates

Steel companies used to be one of the key growth engines of the

Japanese economy. They were on the leading edge of innovation withintheir industry and enjoyed a dominant (if not exclusive) positionsupplying the domestic automakers.

But the Japanese steel producers have struggled since 2008 with adecline in domestic demand.

We dont expect domestic demand will return to past levels anytime

soon.

Close to a third of the steel produced in Japan goes to the

automotive industry. While production has recovered fromthe March 2011 earthquake, most of the major carmakershave announced plans to move production overseas in the last

few months. A government incentive program for eco-

friendly vehicles is lapsing, which could pressure auto sales.And, to make matters worse, the auto industry is the largestbuyer of higher-margin specialty steel products.

Roughly another third of steel produced in Japan goes to the

construction sector, which is currently under pressure. Non-residential fixed investment declined 2% on a seasonallyadjusted basis in 1Q12.

Finally, 15% of steel produced in Japan goes to theshipbuilding sector, which faces lower shipping rates,

declining orders and competition from Chinese and Koreanshipyards. Nikkei recently reported that Japans top fourshipbuilders plan to reduce capacity for the first time in adecade.3

Japanese Domestic Steel Demand by Sector2

Auto35%

Construction

30%

Shipbuilding

15%

Industrial

machinery

9%

Electrical

machinery

5%

Containers

3%

Other3%

Japanese Domestic Steel Shipments (million metric tons)1

0

10

20

30

40

50

60

70

1997 1999 2001 2003 2005 2007 2009 2011

but has declined at a7% average annual rate

from 2007-2011

Domestic steel demand steadily increased

through the early- to mid-2000s


8/32

8

0

2

4

6

8

10

12

2008 2009 2010 2011

Korea China

1H11 1H12

Exports Have Peaked

1. The Japan Iron and Steel Federation: Exports of Ordinary Steel Products

2. The Japan Iron and Steel Federation: January to April 2012

As domestic demand came under pressure, Japanese steel producers

increasingly relied on exports to keep their mills running and marginshigh.

Steel exports increased 36% from 2008 to 2010, reaching almost 40% oftotal production.1

Korea and China are the top destinations, accounting for over one thirdof total exports.2

However, these two markets are now experiencing a slowdown in

demand combined with higher production capacity. In 2011, exports toKorea and China fell 19% and 8%, respectively. The trend has continuedin 2012, with exports to Korea and China down 17% and 16% year-to-date.3

Japan Steel Exports (million metric tons)1

Japanese Steel Exports by Destination2

Korea

21%

China

15%

Taiwan

8%Thailand

11%

USA

7%

Others

38%

Annual Exports to China and Korea (million metric tons)3

Year-to-date exports to

Korea and China are down15% and 16%, respectively

3. The Japan Iron and Steel Federation: Exports of Iron and Steel by Country


0%

10%

20%

30%

40%

0

5

10

15

20

25

30

1997 1999 2001 2003 2005 2007 2009 2011

Steelexports(leftside)Exportsasa%ofproduction(rightside)


9/32

9

Korea Rapidly Becoming a Net Steel Exporter

1. Bloomberg

2. Goldman Sachs, Global Supply & Demand Model, dated July 26, 2012

Korea is Japans largest export destination for steel products (21% of

Japans total steel exports in the first 4 months of 2012).

However, the large Korean steel makers have been investing aggressivelyin new production capacity, and we expect Korea to turn from a netsteel importer to a net steel exporter in 2012.3

New capacity is slated to come online. POSCO (Koreas largest steel producer) is investing $4.1

billion to build a new 2 million metric ton per year blastfurnace in Korea and a 3 million metric ton per year blast

furnace in Indonesia by year-end 2013. These two plantswould increase POSCOs total capacity more than 10%.

Hyundai Steel (Koreas 2nd largest producer) is investing $2.9

billion on a 4 million ton per year capacity expansion, alsoscheduled to come online in 2013. That plant would increase

Hyundai Steels total capacity approximately 25%.

Monthly Crude Steel Production for South Korea

(million metric tons)1

Korea Net Steel Imports (million metric tons)3Annual capacity (million metric tons)2

3. Korean Iron and Steel Association


2

1

0

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

Jan

06 Jan

07 Jan

08 Jan

09 Jan

10 Jan

11 Jan

12

0

10

20

30

40

50

6070

80

90

2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013E


10/32

10

China Aggressively Expanding Steel Production Capacity

1. Bloomberg


3. Bloomberg

4. China Considers Resuming Tax Rebates for Steelmakers, Bloomberg News article dated July 31, 2012

China is Japans 2nd largest export destination for steel products (15% of

Japans total steel exports in the first 4 months of 2012) and has beenexpanding its production capacity aggressively over the past few years.2

In June 2012, trailing twelve month steel production volume was up 5%year-over-year and up 59% from the June 2007 level.1

Given a slowdown in construction and industrial activity in China, weexpect Japanese steel exports to China will come under pressure (and

Chinese imports into Japan will grow). According to recent press articles,the Chinese government is considering a 17% value-added tax rebate fordomestic steelmakers that produce steel for export markets.4

We are also starting to see the signs of pricing pressure.3 For instance,Chinas Baoshan Iron & Steel recently announced that it would reduce

its benchmark price of hot-rolled and cold-rolled steel products for

September delivery. Baosteel has now cut prices three months in a row.

Monthly Crude Steel Production for China


China Domestic Hot-Rolled Coil and 25 mm Rebar

Spot Price (CNY/metric ton)3Annual Capacity (million metric tons)2

0

10

20

30

40

50

60

70

Jan06 Jan07 Jan08 Jan09 Jan10 Jan11 Jan12

0

200

400

600

800

1,000

2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013E


3,500

3,700

3,900

4,100

4,300

4,500

4,700

4,900

5,100

5,300

Hotrolledcoil 25mmrebar


11/32

11

Imports Rising and Competitive Advantage Eroding

1. The Japan Iron and Steel Federation: Ordinary steel products

2. The Japan Iron and Steel Federation: Imports of Iron and Steel by Country

3. The Japan Fair Trade Commission4. POSCO Joins Toyota Top Supplier Group, Challenging Nippon Steel, Bloomberg News article dated June 28, 2012

5. Nippon Steel sues POSCO over technology, Reuters article dated April 25, 2012


Japan Steel Imports (million metric tons)1 Compounding the problems of slowing domestic demand and peakingexports, Japanese steel producers are facing more competition at home.Imports increased 66% from 2009 to 2011 and now account forapproximately 10% of total domestic demand.1

In addition to overcapacity in China (and to a growing extent Korea)and a stronger yen, Japanese producers are losing their technological

edge as foreign producers close the quality gap.

Even the Japanese agree that foreign products are catching up in quality.In its December 14, 2011 ruling on the proposed merger betweenNippon Steel Corporation and Sumitomo Metal, the Japan Fair TradeCommission stated the following regarding hot-rolled sheets:

according to the results of interviews with automobile manufacturers, they

consider the quality and lineup of Korean products to be the same as those of

Japanese blast furnace steelmakers, and may increase import volumes in thefuture.3

In a key vote of confidence, Toyota recently added Korean steelproducer POSCO to its list of top suppliers. POSCO is the first non-

Japanese steelmaker to enter this exclusive group, which represents thetop one percent of Toyotas suppliers.4

Similar to other industries in Japan, the steel producers are facing a

brain drain of talent moving abroad. Nippon Steel recently took theunusual step of suing POSCO and a former employee for $1.3 billion in

damages. Nippon Steel alleges the former employee passed patentedtechnology for grain-oriented steel sheets used in electrical transformersto POSCO.5

0%

2%

4%

6%

8%

10%

12%

0

1

2

3

4

5

6

1997 1999 2001 2003 2005 2007 2009 2011

Steelimports(LHS) Importratio(RHS)

Japan Steel Imports from Korea and China


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2008 2009 2010 2011

Korea China

1H11 1H12


12/32

12

Margins at Risk from Commoditization of Specialty Steel

We view the Japanese steel market as three segments: commodity (~75%), specialty (~20%) and premium (~5%). Approximately 60% of specialty

steel orders come from the auto industry.

Premium products (e.g., engine and powertrain components) are difficult to substitute and thus remain insulated from competition. But for lessspecialized products (e.g., stainless steel, coated sheets and cold-rolled sheets), automakers are increasingly willing to substitute foreign products.

Specialty products typically sell at higher prices and offer better margins for producers vs. commoditized hot-rolled sheets. We expect further price

pressure in this segment.

1. Fore Research & Management estimates2. Steel cycle bottom not in sight; Kobe, Daido downgraded, Bank Of America Merrill Lynch equity research report published on April 17, 2012; Fore Research & Management estimates

Sources: Company reports, Bloomberg and Fore Research & Management estimates

Premium

Daido Steel,Hitachi Metals,

Sanyo Special Steel

Well insulated from

foreign competition

Highly commoditized.Intense pricecompetition.

JFE (~90%), KobeSteel (~65%) Nippon

Steel, Sumitomo

JFE (~10%),Kobe Steel (~35%)

Increasing

Commoditization. Foreigncompetition pressuring

prices.

Hot-rolled sheets

Estimated market split by product type1 Companies2 TrendsProducts2

Tools, bearings,

crankshafts5%

Stainless steel,coated sheets, cold-

rolled sheets

Specialty

20%

Commodity75%


13/32

13

Japanese Steel Makers are No Longer Cost Competitive

Market Share Japanese steel producers are at the high end of the global supply curve.We estimate cash production costs for the largest Japanese steelproducers are, on average, more than 10% higher than Chinese andKorean peers owing to higher labor and processing costs.

The highly fragmented steel industry, which sells finished products to ahandful of large auto OEMs, lacks pricing power.

Illustrating steel producers weak bargaining position, Nippon Steel and

Toyota recently agreed to a Y2,000 per ton price cut through September,retroactive to April. According to Nikkei, Nippon Steel had asked for aY3,000 price increase, citing pressure from higher raw material prices.2

Estimated Cash Production Cost (2011; $ per ton)1

UpstreamThe iron ore and cokingcoal industries are highly

consolidated.

Vale,26%

RioTinto,21%

BHPBilliton,15%

Others,38%

ArcelorMittal,7%

Baosteel,3%POSCO,3%

NipponSteel,3%

JFE,2% JiangsuShagang,2%TataSteel,2%U.S.Steel,2%

AnshanSteel,2%Gerdau,1%Others,76%

GM,10%

Toyota,9%

Hyundai,9%

VW,9%

Ford,

7%

Nissan,6%

PSA,

5%Honda,4%

Renault,3%

Suzuki,3%

Others,35%

DownstreamThe relatively

consolidated autoindustry is negotiating

price reductions

The fragmented steelindustry lacks both

purchasing and

pricing power

1. Fore Research & Management estimates; Goldman Sachs: Cash cost comparisons 2011

2. Nippon Steel, Toyota Agree To Cut Steel Sheet Prices, Nikkei article dated July 27, 2012


$0

$100

$200

$300

$400$500

$600

$700

$800

$900

$1,000

Labor

Processing

Materials


14/32

14

Not Counting on Capacity Reductions or Policy Support

In order to ease the supply/demand imbalance, we believe the Japanese steel

industry would need either (1) excess capacity to come offline; or (2) tradebarriers to restrict the flow of imports.

We dont see capacity reductions on the horizon:

Japans largest blast furnace producers still target volume growth.

Nippon Steel and JFE (Japans #1 and #2 producers, respectively)have issued medium-term business plans calling for the

construction of new blast furnaces overseas.

Two of Japans largest steel producers Nippon Steel and

Sumitomo are merging. One would think this presents anexcellent opportunity to consolidate excess supply, but their statedpost-merger plans include no mention of reduced capacity.

Finally, removing capacity in Japan is difficult and expensive.Struggling semiconductor producer Renesas is a good example. In

early July, the company announced a plan to close 8 plants and cut5,000 employees (23% of its workforce). The company hasntprovided detailed restructuring cost guidance, but sell-side

forecasts imply costs in excess of $160,000 per employee.

We dont expect policy support either:

Unlike the United States, the Japanese government does not levy

tariffs on imported steel products. Japanese manufacturers havetraditionally sourced domestically, so they havent had a need toenforce trade protections. With an economy still largely dependent

on exports, implementing trade barriers now could inviteunwelcome retaliation.

Trade restrictions could also take a while to implement givenbureaucratic hurdles.



Japanese Steel Supply/Demand (left side millionmetric tons) and Utilization (right side)1

0%

10%

20%

30%

40%

50%

60%70%

80%

90%

100%

0

20

40

60

80

100

120

140

2005 2006 2007 2008 2009 2010 2011

Production Capacity Util ization


15/32

15

Agenda

Executive Summary


JFE Holdings, Inc.

Kobe Steel Ltd


16/32

16

JFE Holdings (JFEHLDS) CDS at 265-2901

JFE Holdings is the 2nd largest blast furnace maker in Japan.

In FY12, the company derived roughly 83% of its revenue from its steel business, 9% from

its engineering business and 7% from its shipbuilding business.

The operating environment for JFEs steel business has become increasingly difficult given a

high cost structure and an oversupplied market. Steel demand growth is weak, both in Japan

and overseas. JFE has a higher export ratio than its peers (45% in FY12). But a strong yen has made JFE

less competitive in overseas markets.

In addition, we expect the combination between Nippon Steel and Sumitomo Heavy (whichwould create the worlds second largest steelmaker, with over 50 mn metric tons of annual

production capacity) will intensify domestic competition.

JFEs financial results started to deteriorate in FY12, with EBITDA contracting 34% YoY.

Its steel ordinary income margin turned negative in 4Q12 for the first time in the past 4years.

On April 20, 2012, the company unveiled a new mid-term plan that calls for Y1tn ininvestment over the next three years. We are skeptical that JFE will be able to fund this

capex plan with internal operating cash flow and believe building overseas blast furnaces insearch of growth will likely increase its financial burden.

We estimate EBITDA of Y259 bn in FY13 (down from Y283 bn in FY12) and expect JFEs

net leverage to increase from 5.7x as of 1QFY13 to 6.2x by the end of FY13. We also expectthe company will continue to generate negative FCF in FY13.

JFE has significant near-term maturities: Y338 bn of debt is due in the current fiscal year

(22% of total debt), with only Y42 bn cash on hand as of 1QFY13.

1. Trading levels as of September 13, 2012


Capitalization

31Mar12 30Jun12

Cash 50.4 41.7

OtherCashEquivalents 0.0 0.0

STBankLoans 173.4 91.1

OtherBank

Loans 765.2 772.5

CommercialPaper 0.0 53.0

1.33%Nts'12 20.0 0.0

1.33%Nts'12 30.0 30.0

1.853%CB'13 300.0 300.0

1.278%Nts'13 40.0 40.0

1.351%Nts'15 20.0 20.0

0.927%Nts'14 40.0 40.0

0.708%Nts

'15 40.0 40.0

0.572%Nts'15 60.0 60.0

0.453%Nts'17 0.0 30.0

0.858%Nts'17 20.0 20.0

1.326%Nts'21 30.0 30.0

0.455%Nts'16 20.0 20.0

0.686%Nts'18 15.0 15.0

3.5%Nts'12 20.0 0.0

Others 0.0 0.0

Debt 1,593.6 1,561.6

SharesOutstanding 0.6 0.6

Price 1,394.0 1,113.0

MarketCap. 856. 5 683.9

EnterpriseValue 2,399.8 2,203.7

LTMEBITDA 283.1 264.4

CreditRatios

NetDebt/EBITDA 5.5x 5.7x

Debt/EBITDA 5.6x 5.9x

EV/EBITDA 8.5x 8.3x


17/32

17

JFE Holdings Company Description and Background

JFE Holdings was formed in 2001 by the merger of NKK and Kawasaki Steel.

JFE is one of the largest integrated steel producers in the world, with a crude steel capacity of 33 million tons.

The companys production system primarily revolves around two major steelworks: East Japan Works (where the company built Japansfirst integrated coastal steelworks in the early-1950s) and West Japan Works.

JFE also operates the Chita Works, a large specialized steelworks producing steel pipes and tubes, including tubular applications for the oil

industry.

JFE has also been investing in its own coking coal and iron ore supplies. In December 2009, the company acquired a 20% stake in QcoalsByerwen Coal Mine in Australia, which should become fully operational in 2012. As of March 31, 2011, JFE procured 19% of its cokingcoal and 16% of its iron ore from mines in which it had an interest. The company hopes to achieve 30% raw materials self-sufficiency, buthas no specific timetable for reaching this target.


Steel: Sheets, Plates, Shapes, Pipes and Tubes, Stainless and SpecialtySteels, Electrical Steels, Bars and Wire Rods, Iron Powders Services &Management

Shipbuiding

7%Engineering

9%

Steel

83%

Engineering: Energy Industries Engineering, EnvironmentalIndustries Engineering, Water and Waste Water Engineering, SteelStructure Engineering, Solution Engineering, Machinery Center

Shipbuilding: Large Tankers, Large Bulk Carriers, LPG/LNG

Carriers, Naval Ships, Patrol Vessel, Fishery Surveillance Boats,Anchor-handling Tug & Supply Ships, Ship Repair and Conversion,Defense Equipment

Revenues by segment (FY12)



18/32

18

JFE Holdings Large Exposure to Exports

JFE Holdings has one of highest export ratios among the Japanese steelmakers.

In FY12, 45% of its products were exported.1

In 1QFY13, JFE reported a 48.5% export ratio, up 250 bps quarter-over-quarter. For 2QFY13, the company targets a 49% export ratio, which wouldrepresent a 460 bps year-over-year increase.

The company does not break-down its exports by destination. However, Koreaand China represent approximately 20% and 15% of its Japanese steel exports,

respectively.

We believe that Japanese steel exports to Korea will come down in FY13 and

FY14, as the country turns from a net steel importer to an exporter. We notethat several of the large Korean steelmakers are adding significant new capacity,potentially reducing the need for Japanese products.

In March 2012, JFE reduced its stake in Hyundai Hysco by 4.99 percentagepoints. Since 2000, JFE has been supplying Hyundai Hysco with hot coil and

manufacturing technology for cold-rolled steel sheets used by the automakers.

Reflecting a very challenging environment characterized by oversupply andslowing infrastructure investment, aggregate profit for Chinese steel producersdeclined 96% year-over-year in 1H12.3To help ease the burden on

manufacturers, government officials are considering a 17% value-added taxrebate for exported steel products.4

1. Export ratio on value (and non-consolidated) basis

2. The Japan Iron and Steel Federation: Metric tons; January to April 2012 period3. Chinese Steelmakers Profit Tumbles 96% on Lower Demand, Prices, Bloomberg News article dated July 31, 2012

4. China Considers Resuming Tax Rebates for Steelmakers, Bloomberg News article dated July 31, 2012


Korea

21%

China

15%

Taiwan

8%Thailand

11%

USA

7%

Others

38%

Japan - Steel Exports by Destination2

JFE Export Ratio1

35%

37%

39%

41%

43%

45%

47%

49%

51%

53%

55%

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13E


19/32

19

JFE Holdings Shipbuilding Segment Sinking

JFEs shipbuilding arm, The Universal Shipbuilding Corporation, produced 28

new vessels in FY12, for net sales of Y215 bn.

The companys backlog has been under intense pressure in the past couple ofyears (down 28% in FY12).

We also believe that the Korean and Chinese shipyards have a cost advantageof 25% to 40% on their Japanese peers (part of it from FX, part of it fromlower labor costs).

While the Japanese shipping operators could afford to direct their orders to JFEand its peers in the past, we believe strong headwinds facing Mitsui OSK,

Kawasaki Kisen or Nippon Yusen will lead to a sharp decline in new orders andbacklog over the next couple of years.

We expect JFEs shipbuilding sales and ordinary income trends will continue todeteriorate in FY13. However, as of October 1, 2012, JFEs shipbuildingsegment will become an equity method affiliate and operating results will be

reported below-the-line.

1. Includes inter-segment transactions


0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

31Mar

08 31

Mar

09 31

Mar

10 31

Mar

11 31

Mar

12

Shipbuilding Backlog (Yen, bn)1

Shipbuilding Ordinary Income (Yen, bn)

20

15

10

5

0

5

10

15

20

25

FY09 FY10 FY11 FY12 FY13E


20/32


21/32


22/32

22

JFE Holdings Liquidity


We estimate 22% of total debt (Y338 bn) comes due in thecurrent fiscal year. The company has only Y42 bn of cash onhand as of June 30, 2012.

This does not take into account the FCF deficit that will alsohave to be financed with debt. To make matters worse, the

company has an aggressive investment plan for next three years

calling for total capex of Y1 tn.

Estimated Debt Maturities (Yen, Bn)

0

100

200

300

400

500

600

700

FY13E FY14E FY15E FY16E FY17E Thereafter

CashpositionasofJune

30,2012:Y41.7bn


23/32

23

JFE Holdings Trading Performance

Sources: Bloomberg, as of September 13, 2012

Stock (Yen)CDS (bps)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Jan

08

May

0

8

Sep

08

Jan

09

May

0

9

Sep

09

Jan

10

May

1

0

Sep

10

Jan

11

May

1

1

Sep

11

Jan

12

May

1

2

Sep

12

0

50

100

150

200

250

300

350

Jan

0

8

May

0

8

Sep

08

Jan

0

9

May

0

9

Sep

09

Jan

1

0

May

1

0

Sep

10

Jan

1

1

May

1

1

Sep

11

Jan

1

2

May

1

2

Sep

12


24/32

24

Agenda

Executive Summary


JFE Holdings Inc.

Kobe Steel Ltd


25/32

25

Kobe Steel (KOBSTL) CDS at 500-550;1

Kobe Steel is the 4th largest blast furnace maker in Japan.

In FY12, the company derived roughly 44% of its revenue from its steel business, with the

rest coming from non-steel businesses such as aluminum and copper, constructionmachinery and natural resources and engineering.

Like its peers, Kobe faces a challenging business environment in its steel segment owing tostagnating domestic demand, overcapacity in the Asian market, rising input costs and astrong yen. The steel segments ordinary income margin fell to -8.7% in 4Q12 (Mar 31st,

2012) and the company suffered a loss in this segment for the full year

While steel sheet volumes could be helped by a rebound in automotive production, pricing

could come under pressure. In addition, we expect the demand for cast/forged steel by theshipbuilding industry to decline significantly.

Kobe has significant exposure to China (14% of total sales in FY11) and is vulnerable to aslowdown. We are concerned that Kobes higher-margin construction machinery segment

(16% of FY12s revenue and 58% of ordinary income) will slow down given (1) a noticeabledeceleration in demand from China and (2) fierce price competition from local producers.

As a result, we dont expect Kobes financials to improve soon. For FY13, we estimateEBITDA will decline 35% year-over-year and expect gross leverage will increase to 8.3x(7.4x net) by year-end.

The company expects to burn Y120 bn of cash in FY13. Thats approximately 60% of itsmarket cap.

Kobe also has Y283 bn of debt due in the current fiscal year (31% of total debt), with Y99.8

bn cash on hand as of 1QFY13.

1. Trading levels as of September 13, 2012


Capitalization

31Mar12 30Jun12

Cash 95.4 99.8

OtherCashEquivalents 6.5 0.0

STBank

Loans 204.7 248.0

OtherBankLoans 394.6 391.6

Leases 42.1 42.0

Bonds&notes 207.3 232.3

Others 0.0 0.0

Debt 848.8 914.0

SharesOutstanding 3.1 3.1

Price 119.0 63.0

MarketCap. 370.7 196.2

EnterpriseValue 1,117.6 1,010.4

LTMEBITDA 178.6 145.2

CreditRatios

NetDebt/EBITDA 4.2x 5.6x

Debt/EBITDA 4.8x 6.3x

EV/EBITDA 6.3x 7.0x


26/32

26

Kobe Steel Company Description and Background

Kobe Steel, Ltd. was founded in 1905.

The company is the fourth largest steel producer in Japan, with annual production capacity of approximately 8 million tons.

Kobe Steel operates a diversified mix of industrial businesses under the KOBELCO brand. Products include iron and steel, constructionmachinery, aluminum and copper, welding technology and eco-solutions.

Many of Kobe Steels production facilities were badly damaged in the Great Hanshin-Awaji Earthquake of 1995. Owing to a long and

expensive rebuilding process and a focus on non-steel businesses, Kobe Steel has not invested in facility upgrades to the same extent aspeers. Although its product mix is more skewed toward higher-price specialty products, Kobe Steels production costs are higher thanpeers.

Kobe Steel has also been investing in the procurement of raw materials. In March, Kobe announced a deal to acquire 10% of a new 10million ton per year iron ore mine in Australia for Y25 bn. When expected production begins in 2015, Kobe will procure about 20% of its

iron ore vs. 7% currently.


Revenues by segment (last twelve months)1


27/32

27

Kobe Steel Margin Pressure from Specialty Steel

Kobe Steel has outsized exposure to specialty steel products vs. blast

furnace peers. Neither Kobe Steel nor JFE disclose their product mix,but we estimate approximately 35% of Kobes steel shipments arespecialty, vs. about 10% for JFE.

We view the Japanese steel market in three segments: commodity(~75%), specialty (~20%) and premium (~5%). Approximately 60% of

specialty steel orders come from the auto industry.

Premium products (e.g., engine and powertrain components) are difficultto substitute and thus remain insulated from competition. But for morecommoditized specialty products (e.g., stainless steel and cold-rolledsheets), automakers are increasingly willing to substitute foreign products.

We expect further price pressure in this segment.

1. Steel cycle bottom not in sight; Kobe, Daido downgraded, Bank Of America Merrill Lynch equity research report published on April 17, 2012.Sources: Company reports, Bloomberg and Fore Research & Management estimates

Estimated Exposure to Specialty Steel

(% of sales)1

0%

5%

10%

15%

20%25%

30%

35%

40%

KobeSteel NisshinSteel

Sumitomo

Metal

Industries

Nippon

Steel

JFE


28/32

28

60%

40%

20%

0%

20%

40%

60%

80%

100%

120%

140%

1Apr10

1Jun

10

1Aug

10

1Oct10

1Dec

10

1Feb

11

1Apr11

1Jun

11

1Aug

11

1Oct11

1Dec

11

1Feb

12

1Apr12

1Jun

12

Kobe Steel Exposure to the Chinese Construction Market

Kobe Steel is exposed to the Chinese construction market through its steel

exports.

In addition, Kobes Kobelco Construction Machinery subsidiary (whichmanufactures hydraulic excavators and wheel loaders) has significant exposureto China and has identified China and Southeast Asia as areas of focus.

Kobelco Construction Machinery represented only 16% of Kobes total

revenues in FY12, but 68% of its ordinary income (up from 29% in FY11).

We expect Kobelco Construction Machinerys performance to deterioratesignificantly in FY13, as the company is impacted by the slowdown in Chinese

construction activity.

We note that Komatsu reported a 38% YoY decline in orders of hydraulicexcavators in China in July 2012, in spite of an easier comparison with theprior years numbers (July 2011 was down 32% YoY).

In 1QF13, Kobelco Construction Machinery revenue declined 18% year-over-year, despite reconstruction activity driving a year-over-year increase in

domestic sales. The company is still guiding to approximately flat revenues inFY13 and to achieve this target, 2HF13 revenue would have to increase 22%year-over-year.

As a result, we expect Kobelco Construction Machinerys ordinary income ofY8.8 bn in FY13, down from Y22.9 bn in FY12.

1. 6-ton class and overSources: Company reports, Bloomberg and Fore Research & Management estimates

Komatsus Monthly Hydraulic Excavator Orders

in China (YoY Change)1

-38% YoY decline in

July 2012

Kobelcos LTM Ordinary Income (Yen, bn)

0

5

10

15

20

25

30


29/32


30/32


31/32

31

Kobe Steel Liquidity


We estimate 31% of total debt (Y283 bn) comes due in thecurrent fiscal year. The company has Y100 bn of cash on hand asof June 30, 2012.

Estimated Debt Maturities (Yen, Bn)

0

50

100

150

200

250

300

FY13E FY14E FY15E FY16E FY17E Thereaft er

Cashpositionat

June30,2012:

Y99.8bn


32/32

32

Kobe Steel Trading Performance

Sources: Bloomberg, as of September 13, 2012

Stock (Yen)CDS (bps)

0

50

100

150

200250

300

350

400

Ja

n08

May

08

Se

p08

Ja

n09

May

09

Se

p09

Ja

n10

May

10

Se

p10

Ja

n11

May

11

Se

p11

Ja

n12

May

12

Se

p12

0

100

200

300

400

500

600

Ja

n08

Ma

y08

Se

p08

Ja

n09

Ma

y09

Se

p09

Ja

n10

Ma

y10

Se

p10

Ja

n11

Ma

y11

Se

p11

Ja

n12

Ma

y12

Se

p12

Documents

Japan Steel Industry Update - September 17 2012